AmericanOpinion

Runaway China

As China presses ahead with its economic revolution, its dependence on the United States is becoming less important.

By Ben Simpfendorfer

China is the poorest member to enter the world's richest club. It is a contradiction that explains much about the country's own challenges, and its relationship with the United States.

When China recently overtook Japan as the world's second largest economy, it was an event that captured global headlines. Yet, rather than trumpet its success, China focused instead on the importance of raising incomes to developed world levels. The fact that China's purchasing power parity-based per capita GDP is just $6600, against Japan's $32,600, is a point that rubs sores with those who have not benefited from the country's robust growth.

It is an important distinction. The United States can either focus on the China that is the world's second-largest economy, or the China that is as poor as Algeria and Namibia.

Focusing on the second will result in a better alignment of interests. China might have once sought to capture world number one titles, but it is increasingly focused on creating a 'fairer' society, rather than 'faster' growth. This is the only way to redress the country's imbalanced economy, which has so far largely benefited factory owners and wealthy coastal provinces, to prevent it resulting in social unrest.

True, China has emerged from the crisis in a far more robust position than most other economies. It grew 11 per cent last year, buoyed to a large part by fiscal stimulus, but also stronger domestic demand. There were worries the economy was slowing again in 2010, but it has since bounced back, even shaking off tightening measures targeting the property sector.

Neither is the United States as important as popularly believed. Only 23 per cent of China's exports are shipped to the US, the share having fallen from a large 29 per cent over the past decade, as China ships more to Europe and, increasingly, the emerging markets. The fact that China's market share in America's retail malls and stores is already high also serves as a growing restraint.

So has China decoupled? In so far as the United States is still the world's largest growth engine, China remains exposed to indirect effects. Were the American economy to double-dip over the coming year, growth in Europe and the emerging markets would also likely slow, to the detriment of China's export factories. Still, the relationship is weaker than it was in the past.

It might then appear odd to many that China is worried about its growth model. Yet, the global crisis has shone a spotlight on the many problems with its domestic economy.

The first is that the country is at the tail-end of a decade-long boom driven primarily by liberalisation of the housing sector and outsourcing from mainly North Asian manufacturers. Another round of economic reform is needed to ensure that the boom is sustained. Yet reform has slowed, even reversed, in some sectors.

The second is that American consumers will not play the same role they once did. The global crisis has left many saddled with debt and worried about anaemic job growth. No wonder then that China's exports to the United States have still yet to surpass the peaks they reached as the crisis took hold in the final months of 2008.

The third is that it is no longer enough to rely on the manufacturing sector alone. Domestic consumers cannot make up the shortfall from weak foreign demand, not least US demand. And while sales volume growth is rising, margin growth is falling because of intensifying competition. Continuing to pursue a low-cost, and low-margin, growth strategy will only end badly.

Comparisons with Japan are thus timely; it is the only other Asian economy to make the world's Top 10 list and it shares features with China that the other developed economies do not. But while it is popular to make comparisons with Japan's bubble-economy of the 1990s, it is the 1970s that offer the more instructive lesson.

It was then that oil prices spiked, creating a global crisis. Japan could have responded by throwing subsidies at their manufacturing sector. Instead officials strove to reduce the economy's energy intensity, while manufacturers invested in more energy-efficient capital equipment. It is a response Chinese officials and manufacturers could learn from in grappling with their current problems.

Wang Yang, the party chief of China's Guangdong province, has cited Japan's experience as a model for China. He says the country should use today's economic crisis as an opportunity to reform its own manufacturing sector, rather than provide it a lifeline through VAT export rebates. It should close down the low value-added manufacturers that pay low wages, waste resources and generate little return.

His comments were not well received by all in Beijing. Jobs are, after all, key.

In this respect, Japan again offers another lesson. It was also in the 1970s that the country's services sector overtook manufacturing as having the larger share of the overall economy. Financial, logistics, tourism and health services all started to grow more rapidly, helped in part by the restructuring taking place in manufacturing.

Developing China's service sector is likewise crucial if the country hopes to successfully rebalance away from low-cost manufacturing.

If it does, the United States stands to benefit most.

The US is a particularly competitive producer of services. Health, finance, entertainment and tourism are already valuable exports. The problem is that China's entry to the World Trade Organisation never seriously dealt with services, as it did manufacturing. And the services sector remains largely closed to foreign companies.

Pressure must be exerted on China to reverse its stance. The benefits of developing a services sector, with the help of foreign companies, must be demonstrated. Is it an impossible task? Perhaps not. Beijing can be receptive to 'constructive' criticism, especially if it results in the type of job and income growth that sustains a decade-long boom.

Yet there are still only tentative signs that China will listen. It might take a new leadership, after the transition in 2012, to usher in a new round of economic reforms.

In the meantime, the US–China Strategic Economic Dialogue offers a useful forum for advocating reform. Better coordination with European partners is also important. The European countries, especially the United Kingdom, have as much to benefit from service sector liberalisation. And recreating the coordinated pressure of China's earlier WTO negotiations would advance common interests.

And so the United States, much like China, stands at a crossroads.

It could choose to focus on China only as a strategic competitor. Or it could realign its interests with those of China by helping to rebalance the domestic economy and limit the possibility of social unrest. In doing so, it might just find a growing market for its own service exports, from Hollywood films to private clinics, in what may one day be the world's largest economy.